I told the Subcommittee that we are working now to develop a plan for converting to the Continuous Net, or Net-by-Net, accounting system which could replace the Delivery Balance Order system now used by the New York and American Stock Exchange Clearing Corporations.

It appears that the continuous net system would pose the fewest problems in implementing a national clearing system and would offer maximum advantages to both the securities industry and the investing public.

Senator WILLIAMS. Mr. Herman W. Bevis, member and former executive director of the Banking and Securities Industry Committee, has returned to our witness table. We appreciate your being here again today.

STATEMENT OF HERMAN W. BEVIS, MEMBER AND FORMER EXECUTIVE DIRECTOR OF THE BANKING AND SECURITIES INDUSTRY COMMITTEE, ACCOMPANIED BY HAMILTON F. POTTER, JR., COUNSEL

Mr. BEVIS. Mr. Chairman, gentlemen, I appreciate the opportunity again to appear before you on behalf of BASIC to discuss legislation having to do with securities depositories. I am accompanied by Hamilton F. Potter, Jr., of Sullivan & Cromwell, counsel to BASIC.

My comments on S. 2058 are confined solely to those provisions having to do with depositories. I offer no comments, pro or con, with regard to provisions having to do with clearing systems, transfer agents and registrars, and other matters covered by the bill.

My oral comments, Mr. Chairman, will follow pretty closely the first three pages of the written statement.

The first point I would make is that we feel that additional legislation is not needed for regulation of depositories at this time.

A comprehensive securities depository system has been developed rapidly during the past 3 years under existing regulatory law. Since my last appearance before this subcommittee, substantial, tangible progress has been made toward the immobilization of securities certificates and book-entry transfer of ownership.

There are now three existing depositories, all of which have been or are being chartered as limited-purpose trust companies under State banking laws, one has become a member bank of the Federal Reserve System and the other two plan to apply for membership. The charters, bylaws, and rules of two depositories have been presented to the SEC for review and clearance and the third is in the process of clearance. Thus, the two significant Federal regulatory authorities considered in S. 2058 are already engaged. No problem traceable to inadequate regulatory authority has been encountered and none is expected.

If we assume Federal legislation regarding depositories is to be enacted, we are concerned because S. 2058 does not sufficiently reflect the finding that "the bank regulatory agencies must play a major role in the development of a national clearing system." Those words are from your statement, Mr. Chairman, on the Senate floor in introducing this bill. The bill provides broad SEC rulemaking powers with respect to depositories, but is virtually silent as to rulemaking by bank regulatory authorities.

Depositories must involve much more than the securities industry and the SEC as that industry's regulator. Banks and other nonbroker/ dealer fiduciary financial institutions, whose participation in any nationwide system of depositories is essential, want "safety first" as the

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regulatory cornerstone before they relinquish possession of assets they hold for others. To them, this means that depositories should not only look like banks and act like banks, but be regulated like banks.

I think the Congress should recognize this desire for assurance of safety-I believe the Congress shares it-and, if it is decided there should be legislation, should select the Federal Reserve System as the prime Federal regulator for bank-chartered depositories in view of its experience, capacity, and philosophy in regulation where safety and financial integrity come first, especially in the areas of safeguards, protection of securities and funds, and related matters such as access. We recognize that such a structure goes against the System's concept that a single agency-the SEC-should have sole authority. However, this is a situation in which a concept, if followed straight through, will not necessarily yield the desired result, and we think the advantages to be gained outweigh the natural inclination to provide for a single regulator responsible for all securities processing matters.

In the subsequent discussion and in attachments, we offer suggested changes in S. 2058 designed to give the Board of Governors of the Federal Reserve System rulemaking authority directly related to the Board's supervisory and examination functions for depositories that are members of its System. We firmly believe that the changes we propose will assist in the development of a comprehensive securities depository system that has a far greater chance of reaching the scale of participation that is urgently needed.

ELIGIBILITY OF PARTICIPANTS IN DEPOSITORIES

Senate bill 2058 limits a depository's latitude to deny access to potential participants in a way that I consider exposes a depository and its participants to undue risk.

BASIC has consistently recommended that, subject to regulation, a depository not be absolutely prohibited from subjecting an applicant to tests of character, financial condition, or operational capability.

We are glad to see in section 17A (c) (2) of S. 2058 that an operational capacity test for applicants has been added. We continue to believe that a depository should not be precluded for screening applicants on the basis of character and financial condition.

Management participation: As in last year's S. 3876, section 17A (c) (3) of S. 2058 continues to provide that participants, in addition to stockholders, among other things participate in selection of a depository's officers and directors and in all other phases of the administration of its affairs.

Ample provision can be made that participants can become owners, thus encompassing what is believed to be the principle behind section 17A (c) (3). Our objection is that this section is in direct conflict with the relevant corporation laws under which depositories are being incorporated.

We see no need to invite confusion and conflict to accommodate the desirable principle involved, and which, we believe, can be met in the proposed revision of section 17A (c) (3).

Section 17 (A) (1) of S. 2058 gives enforcement authority over depositories that are banks to the appropriate bank regulatory agency. Section 21 of the 1934 act, which is not modified by S. 2058, gives substantially the same authority to the SEC.

Last year, in connection with S. 3876, the committee report made clear that it is not contemplated that SEC examinations would be a matter of routine but, so to speak, made only under unusual or exceptional circumstances. Senator Bennett repeated the point on the Senate floor. We hope that this point is repeated and made even clearer in the legislative history of S. 2058 if a specific provision is not included in the bill.

I should like to add two points, Mr. Chairman, to what is in the written statement. Yesterday there was some discussion and some questioning about transfer agent depositories. Transfer agent depositories are not a new idea, having been around for several years. So when BASIC was formed and started studying these various potential solutions to the securities handling problem we, among other things, studied the transfer agent depository idea, and we prepared a white paper on TAD in July of 1971. If you wish, I shall be glad to submit for the record this paper which examines TAD's versus comprehensive securities deposit systems in great detail.

Senator WILLIAMS. That would be helpful. Thank you. [The full text of this paper follows:]

BANKING AND SECURITIES INDUSTRY COMMITTEE

TAD v. CSDS

(A Task Force Analysis of The "Transfer Agent
Depository" Idea in Relation to that of the
"Comprehensive Securities Depository System")

(7/19/71)

Summary

The "Transfer Agent Depository" is a term used by many to describe a proposed improved securities transaction processing system for the future. An examination of these proposals leads to the conclusion that the TAD term is being applied indiscriminately to two radically different concepts:

(1) A certificateless system whereunder transfer agents
would maintain the official records of securities
ownership and changes therein. A transfer agent's
record for a given issue would take the place of
certificates as the contra against which would be
balanced the recorded position in that issue of
financial organizations, individuals, and others.
By the same token, financial organizations and
others owning or holding many securities would
balance their recorded positions against the records
of as many agents as transferred the issues.

(2)

A system, not contemplating near-term elimination
of the certificate, in which the transfer agent
would add only the certificate custody function
to his present responsibilities. Ownership of
the shares represented by these certificates held
by the transfer agent would be recorded by a
centralized record keeping service for all fungible
issues. This service would balance its securities
positions against the holdings of the transfer agents,
on the one side, and of its depositors, on the other.

BASIC's plans follow the second system much more closely

than the first. BASIC believes that its approach toward extensive

immobilization of certificates in what it has chosen to call a

Comprehensive Securities Depository System will, when compared with

all the alternatives advanced to date:

Give the needed relief from securities handling problems
much more quickly (involving, as it does, only an
extension of an already huge immobilization facility
CCS);

Accomplish the transition to the system of the future
with less cost (again, merely building on CCS);

Require fewer changes in practices and procedures (almost
none for broker/dealers, but important ones for banks
and others that presently file physical securities by
account);

Provide more quickly a system under which the certificate
could be completely eliminated, if that should ultimately
be deemed desirable.

The problem: Reducing or

eliminating certificate movements

There is widespread agreement that the reduction of certifi

cate movements should be the most important goal of the securities industry. North American Rockwell, in its Final Report to the American Stock Exchange, says; .."taking securities certificates out of circulation, placing them in depositories and automating the accounting

...

process is the answer to the operations problems of the securities industry". (1)

It is asserted that the accomplishment of this goal will result in a substantial reduction of operations costs. Frank Zarb has

(1) N.A.R. Information Systems Company; Securities Industry Overview Study; Final Report to the American Stock Exchange, September 1969 p.39